You have attracted an investor to a startup. What documents do you need to complete first?

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

To avoid unpleasant surprises, choose your business partners carefully and always support your relationship with documents.

Artur Shmoilov Lawyer at Tomashevskaya & Partners.

Alexey Kotomin Lawyer at Tomashevskaya & Partners.

At the very beginning, startups often look like this: two programmers are sitting in a cramped room, concentrating on "sawing" code on computers. There is no one else on the staff. From time to time they attract freelancers for some tasks, but they do not think about reporting at all. But after a while they understand that they need to develop, and this requires funds.

Thanks to a fortunate coincidence, they find an investor who is ready to invest money and even offers his lawyer to complete the necessary papers. The parties sign an agreement, but just at the moment when the startup starts to make the first profit, and the business grows, the founders suddenly discover the first surprises, which are not always pleasant.

The thing is that, without understanding, they signed an agreement containing onerous terms of cooperation. We will figure out what to look for in order to avoid unpleasant situations, and which documents can regulate the relationship between a startup and an investor.

Term Sheet, or agreement of intent

This is the very first document that puts your verbal agreements with the investor on paper. Usually, it indicates the amount of investment, the size of the share that the investor will receive, the investor's rights in relation to the company's shares, your rights, and the specifics of further financial and legal documentation.

It would be good to understand at this stage whether you will choose a loan agreement or an option agreement, as well as the jurisdiction in which your company will operate and where your intellectual property will be registered, if any.

If your project is focused only on the Russian market, for example, you produce samovars, register in Russia. If you have an IT project with which you want to enter the global market, analyze where it is better to store intellectual property and where it is easier to pay taxes. To do this, you need to contact an intellectual property lawyer with experience in structuring cross-border transactions.

Service in the offshore jurisdictions of Cyprus, the Cayman Islands is cheaper, but the price should not be the only criterion for your choice.

In any case, you should focus on the jurisdiction that regulates the operation of the main market in which the company expects to sell its goods or provide services.

Term Sheet, as a rule, has no legal force and can be a very small document - just a few A4 sheets. However, at a minimum, all participants must sign it, and as a maximum, you can still pay attention to the conditions that, if necessary, one of the parties can still declare in court. Usually they relate to the confidentiality of the transaction and the exclusivity of the agreements. For example, in the letter of intent it will be written whether you can apply in parallel to another investor or not.

Examples of such conditions:

"The parties undertake to treat all discussions related to the transaction provided for in this Agreement of Intent, as well as to this Agreement of Intent, as confidential."

“The Company and the Founders have agreed on an exclusive period until …, during which the Company and the Founders undertake not to enter into or induce to enter into negotiations and / or otherwise engage in active interaction with any third party, initiate or proceed to injecting capital by issuing shares or other securities of the Company or by attracting debt financing (except for ordinary business activities)."

The choice of further documents will depend on the financing model that you choose together with the investor. In any case, all legal documents prescribe the financing goals, and they should be quite specific - research & development, hiring employees, and so on.

Restrictions on the use of investments are also legally fixed, that is, those limits beyond which a startup that has received money cannot go. Violation of agreements threatens with a return on investment or an immediate conversion of funds into shares and shares of the company.

Convertible loan agreement

A convertible loan gives the investor the opportunity to make an investment quickly without spending a lot of time negotiating the terms of their participation in the company. In fact, the investor lends a certain amount of money to the company, and in return acquires the right to return either this amount together with interest, or a certain number of the company's shares. The number of shares is calculated based on the company's valuation at the date of the loan.

Do not forget about the restrictions: it is reasonable to draw up this agreement if your company is not registered in the Russian Federation, but for example, in England, the USA or some kind of offshore zone. At the moment, in the Russian Federation, the mechanism for transferring shares from founders to investors is not working well.

Option or option agreement

This is an alternative to a loan agreement that suits those companies that are registered in Russia.

Since June 1, 2015, two new articles have appeared in the Civil Code of the Russian Federation: on the option Art. 429.2 of the Civil Code of the Russian Federation for the conclusion of an agreement and an option agreement Art. 429.3 of the Civil Code of the Russian Federation. What unites these documents is that the parties agree on conditions that must be fulfilled not immediately, but in the future. The difference is in what the entitled party gets.

With the option to conclude a contract, one party to the agreement grants the other party the right to conclude one or more contracts on the terms determined by the option. As a rule, it is provided for a fee. But under the option agreement, one party, on the conditions provided for by this agreement, has the right to demand from the other party to perform certain actions (payment of a sum of money, transfer of property, and so on) within a specified period. If the entitled party does not file a claim within the specified time period, the option agreement is terminated.

An option agreement, unlike an option, does not require the conclusion of the main agreement. It gives the right to demand execution upon the occurrence of certain circumstances.

Usually, two options are implemented - providing for the exit from the company or, on the contrary, the establishment of control over it. In the first case, the business owners or option investors have the right to sell the company's shares or shares in the authorized capital in the future at a predetermined price upon the occurrence of certain circumstances. In the second case, a different situation is considered - the ability to establish control over the acquired company in the event that profitability meets the expectations of the buyer. Then the entitled party receives the right to redeem the shares or share of the authorized capital remaining at the disposal of the counterparty. The price is also calculated in advance.

Shareholder agreement

Imagine the situation. You just graduated from a prestigious university and started a startup. Themselves headed the team as CEO, found an investor. The investor understood that the company would not immediately make a profit, and agreed to give you six months for development. At the very beginning, to celebrate, you signed a bunch of papers with lawyers, and then plunged into work. You had an excellent relationship with the investor, and he did not interfere at all in the activities of the startup. And one morning, arriving at the office, you find that the CEO is no longer you, but a completely different person.

What did you do wrong? Why did this situation happen at all? The answer is simple: when you signed the shareholder agreement, you did not pay attention to the key point - whether the investor has the right to appoint his CEO.

The shareholder agreement is intended to regulate relations between shareholders in the company. According to this document, the parties agree on how to manage, how to distribute profits, whether they undertake to nominate their candidates to the board of directors. Also prescribed:

• who can fire key executives;
• who can appoint a CEO and CFO or engage a financial controller;
• what issues should be decided only by the board of directors, and what issues the CEO himself has the right to decide;
• what documents can be requested by this or that shareholder and how often.

Drafting and approval of the document usually takes several weeks. It is concluded between all or several shareholders and regulates all major issues in the life of the company.

Business plan

This is an optional appendix to the shareholder agreement. In this document, the company describes what funds and what exactly it is going to spend. To mitigate risks, in some cases, investors set criteria for deviating from the business plan. For example, if a company deviates more than 30%, the investor may demand a return on investment or a transfer of control.

Documents confirming the registration of intellectual property

Startups always have an acute problem of intellectual property. It was either not registered properly, or it was not correctly transferred to the company from the developers. So, for example, freelancers who send you a code are just the producers of that very intellectual property.

Before starting the development, it is necessary to conclude an agreement on the performance of work (or the provision of services) and draw up a technical task: how the work is done and what exactly is its result. And then with each freelancer to sign the acceptance certificate. And then this is proof for the investor that the code belongs to your company. After the conclusion of the transaction, it is added to the balance of the legal entity.

Title Deeds

If you are married at the time of the deal with the investor, sign an agreement with your spouse, according to which she or he does not object to the sale of the share in the company or the conclusion of transactions.

It doesn't matter that you only own a couple of computers so far. This is a typical document, the signing of which, however, is often neglected. But spouses can get divorced and start sharing joint property. Or the spouse declares that she was initially against the deal, the court declares it invalid and obliges you to return the share to the investor.

In practice, many startups fall apart due to disagreements between founders and investors. In order to avoid this, always study potential partners and approach the choice of investors not only in terms of future financial investments, but also in terms of common views on the further development of the business. And support your feelings with legal documents.